Canada's Housing Affordability Wanes in the First Quarter of 2012: RBC Economics

TORONTO, May 29, 2012 Following two consecutive quarters of encouraging improvements, Canada's housing affordability deteriorated slightly in the early months of 2012, according to the latest Housing Trends and Affordability Report released today by RBC Economics Research. Vigorous homebuyer demand pushed home prices higher in the first quarter, driving the cost of owning a home in Canada modestly upwards.

"It became a little tougher on household budgets to carry the costs of owning a home at market prices at the start of this year," said Craig Wright, senior vice-president and chief economist, RBC. "Strong buyer demand was a principal driver of the modest rise in homeownership costs. While the deterioration in affordability was felt to varying degrees across the country, it was mild in most cases."

Looking ahead, RBC expects further challenges on the affordability front across Canada once the Bank of Canada begins raising interest rates in the fourth quarter of 2012 and assuming the European economy stays on the rails.

"Exceptionally low interest rates have been the key force in keeping affordability from hitting dangerous levels in Canada in recent years," added Wright. "Affordability headwinds are likely to increase next year, as interest rates make their way towards more normal levels. We anticipate that the central bank will begin hiking rates gradually, however, which should help mitigate any widespread negative impact on the housing market. A gradual pace of increases will allow income growth to provide some offset."

The RBC housing affordability measure captures the proportion of pre-tax household income that would be needed to service the costs of owning a specified category of home at going market values. During the first quarter of 2012, measures at the national level rose between 0.3 and 0.8 percentage points for the three housing categories tracked by RBC (a rise in the measure represents deterioration in affordability). Measures stand slightly above historical averages and Canada's housing market remain fairly balanced, indicating that only modest stress is being exerted on housing demand at this point.

Stark regional divergences in affordability witnessed last year carried through to the first quarter of 2012. British Columbia's housing and, more expressly, the Vancouver-area market are situated at the weaker end of the affordability spectrum, while housing markets in Alberta and Atlantic Canada remain at the more affordable end. Local housing markets in Ontario had slightly less attractive affordability in comparison to the national average, while markets in Saskatchewan, Manitoba and Quebec were slightly more attractive.

The RBC housing affordability measure, which has been compiled since 1985, is based on the costs of owning a detached bungalow (a reasonable property benchmark for the housing market in Canada) at market value. Alternative housing types are also presented, including a standard two-storey home and a standard condominium apartment. The higher the reading, the more difficult it is to afford a home at market values. For example, an affordability reading of 50 per cent means that homeownership costs, including mortgage payments, utilities and property taxes, would take up 50 per cent of a typical household's monthly pre-tax income.

After recording marginal improvements in the latter half of 2011, affordability in B.C. remained poor in the first quarter. Measures for the three housing types tracked by RBC moved in different directions in the latest period, primarily reflecting the pace of home price increases for each housing type. This poor affordability is likely weighing on buyer demand and a key factor behind the downward trend in home resales since last fall. RBC expects this pressure to persist going forward.

Following two consecutive quarters of declines, home prices rebounded across all housing types in the Vancouver area in the first quarter of 2012, making it even more difficult for a typical household to own a home in the area. RBC measures rose between 0.3 and 3.1 percentage points, raising doubts that significant affordability improvements will surface anytime soon.

Alberta's housing affordability levels remained attractive in the first quarter of 2012, with RBC's measures for the province standing among the lowest, if not the lowest, across the country. A strong provincial economy and relatively affordable housing pushed home resale activity up 11.5 per cent year-over-year. As Alberta continues to lead the country in economic growth this year, RBC expects brisk housing activity to persevere.

The long-awaited resurgence of Calgary's housing market appears to have launched in recent months. Home resales were up a notable 7.4 per cent in the first quarter, compared to the fourth quarter of 2011. Still, home prices have remained flat, for the most part, keeping housing affordability in check, with some of the best levels among Canada's largest cities. RBC expects the home resale market resurgence to continue through the remainder of the year.

Saskatchewan was the only province to show across-the-board improvement in housing affordability in the first quarter of 2012. Minor price increases - or even declines in the case of two-story homes - in the first three months of the year helped lower the cost of owning a home for all housing categories in the province. Measures fell between 0.2 and 2.0 percentage points, bringing affordability levels even closer to long-term averages and implying that any undue stress on homebuyers is dissipating. Looking ahead, rapid provincial economic growth will continue to support Saskatchewan's housing market.

In the first quarter, there was little change to Manitoba's affordability picture, with RBC measures moving only slightly. In fact, Manitoba's housing market is one of the more affordable in the country. The share of household income needed to cover the costs of owning a home at market value was generally in line with historical norms and continued to be a reasonably neutral financial burden for homebuyers. So far this year, resales have been quite volatile, registering a decline in the first quarter. RBC expects this will be a temporary pullback and that resales will continue to make gains this year.

Ontario's housing affordability eroded slightly in the first quarter of 2012, amid rising home prices in some of the province's largest markets. The affordability picture in the province is somewhat tougher than it has been on average over the long-run, especially for single family homes, where property values appreciated the most in the past year. While this may cause some underlying stress in the market, it has yet to slow housing demand in the province. RBC expects the recent surge in housing starts will eventually help to address tight market supply.

Toronto's housing market is firing on all cylinders. Home resales increased to their highest level in two years and year-to-date monthly figures stood 14 per cent above the 10-year average in the area. Brisk demand has outpaced the supply of existing homes in the past year, with sellers retaining the upper hand. RBC expects that, if affordability continues to deteriorate, it will eventually serve as a deterrent for homebuyers.

Ottawa area homebuyers were more hesitant to close deals, despite the greater availability of homes for sale. This reluctance might be related to weakened housing affordability late last year and in the first quarter of 2012, when measures rose between 0.4 and 0.9 percentage points, pushing levels further above long-term averages. This could signal that homebuyers are feeling stretched in the face of current market valuations. RBC notes, however, that Ottawa is not out of line relative to national standards and does not expect to see the kind of pressure that could destabilize the market in the period ahead.

Much of the affordability improvement in the second half of last year was rolled back in the early months of 2012. Quebec saw the strongest increases in single family home prices in Canada, causing a notable deterioration in affordability for both detached bungalows and two-storey homes. Despite this deterioration, affordability remains within range of historical norms and does not appear to be exerting too much pressure on homebuyers at this point.

Following rapid acceleration through the summer and fall of last year, home resale activity stabilized in the Montreal area in the early months of this year. In contrast, home prices made noticeable gains recently, reversing declines in previous periods. With the exception of two-storey homes, which appear to be pushing the affordability envelope, owning a home in the Montreal area is not currently an excessive financial burden for homebuyers.

Atlantic Canada's housing affordability levels remained in neutral for the most part in the first quarter, following back-to-back improvements in the latter half of last year. The share of household budget needed to cover the costs of owning a home at market values remained in line with long-term averages and compared favourably with other provinces. Homebuyers were quite engaged in the region, as home resales picked up further in the first quarter and activity in Halifax continued to be brisk. Still, RBC notes that home price appreciation in Atlantic Canada remained subdued for the most part.